The US fears that Saudi Arabia, the world’s largest crude oil exporter, may not have enough reserves to prevent oil prices escalating, confidential cables from its embassy in Riyadh show.

The cables, released by WikiLeaks, urge Washington to take seriously a warning from a senior Saudi government oil executive that the kingdom’s crude oil reserves may have been overstated by as much as 300bn barrels – nearly 40%.

The revelation comes as the oil price has soared in recent weeks to more than $100 a barrel on global demand and tensions in the Middle East. Many analysts expect that the Saudis and their Opec cartel partners would pump more oil if rising prices threatened to choke off demand.

However, Sadad al-Husseini, a geologist and former head of exploration at the Saudi oil monopoly Aramco, met the US consul general in Riyadh in November 2007 and told the US diplomat that Aramco’s 12.5m barrel-a-day capacity needed to keep a lid on prices could not be reached.

According to the cables, which date between 2007-09, Husseini said Saudi Arabia might reach an output of 12m barrels a day in 10 years but before then – possibly as early as 2012 – global oil production would have hit its highest point. This crunch point is known as “peak oil“.

Husseini said that at that point Aramco would not be able to stop the rise of global oil prices because the Saudi energy industry had overstated its recoverable reserves to spur foreign investment. He argued that Aramco had badly underestimated the time needed to bring new oil on tap.

One cable said: “According to al-Husseini, the crux of the issue is twofold. First, it is possible that Saudi reserves are not as bountiful as sometimes described, and the timeline for their production not as unrestrained as Aramco and energy optimists would like to portray.”

It went on: “In a presentation, Abdallah al-Saif, current Aramco senior vice-president for exploration, reported that Aramco has 716bn barrels of total reserves, of which 51% are recoverable, and that in 20 years Aramco will have 900bn barrels of reserves.

“Al-Husseini disagrees with this analysis, believing Aramco’s reserves are overstated by as much as 300bn barrels. In his view once 50% of original proven reserves has been reached … a steady output in decline will ensue and no amount of effort will be able to stop it. He believes that what will result is a plateau in total output that will last approximately 15 years followed by decreasing output.”

This won’t come as a surprise to anyone who’s been following the oil industry over the past few years. Matthew Simmons’ Twilight in the Desert, which I reviewed six years ago, made a detailed case that Saudi Arabia’s production capacity had pretty much maxed out already, and Business Week published an article three years ago based on internal Saudi documents that said much the same: the Saudis could pump 12 million barrels a day in short spurts but only 10 million barrels on a steady basis — and that’s all there is. Production capacity just isn’t going up.

The issue is pivotal. Put simply, the price of oil — the price you are paying at the pump, indeed the cost of everything in your home — is wholly determined by what oil traders think Saudi reserves and production capability really are. As an example, oil plunged yesterday to their lowest price of the year — $87.87 a barrel — when Saudi Arabian Oil Minister Ali al-Naimi (pictured above) suggested that the kingdom will put new oil supplies on the market to compensate for any uptick in global demand.

The thing is, the Saudis are highly secretive about these figures — unlike almost every important petro-state on the Earth outside the Middle East, the Saudis will not permit their oilfields to be independently audited. One might wonder why that would be the case, and the late Matt Simmons, for example, made much hay suggesting that the reason is that the Saudis simply don’t have as much oil as they claim. I myself got ahold of documents back in 2008 suggesting the same. Sensible voices, however, said such are the thoughts of the conspiratorial-minded, and that the Saudis genuinely possess what they claimed — they were denying the right to verify because … well because that’s just what they do.

It’s interesting to look at recent production data with this kind of news in mind (to see production numbers you can download this PDF, or check out charts at the Oil Drum). What we observe is that from around 2004, oil production hasn’t increased very much, even as prices have soared. Now, one reason for this plateau may be the lag in bringing new supply online. During the cheap oil 1990s, production growth and exploration were limited. As prices rose in the early 2000s, producers brought existing, high-cost facilities online, adding to supply. But once existing production was running at capacity, the industry had to wait to get new facilities up to increase supply, and that process doesn’t happen overnight. So it could be that, globally, we’re experiencing a temporary period of high prices and stagnant supply while new extraction is set up.

Of course, in an environment of growing demand, a temporary supply limit can be costly.

But let’s think about one other potential dynamic. In the old days, OPEC attempted to use its cartel status to artificially limit supply and raise prices. This, however, was difficult to orchestrate; there was always the incentive to cheat and sell more than one’s quote of oil at the artificially high price, and as more participants cheated the supply limit fell apart. But as global supply runs against natural limits, incentives begin shifting the other way.

If an individual gains information suggesting that oil reserves are overstated, then they’re likely to expect an increase in future prices. Such an individual could bet on this outcome by buying oil futures, but this behaviour is limited by the nature of the contract; at some point traders may need to take delivery of actual oil, in which case they’ll need a place to store it, and that storing activity would be highly visible in the form of rising inventories.

But what if you’re an oil producer, and you learn this information? Well, obviously you’d like to make the same bet, and hold on to your oil until you can sell it at a higher price. Fortunately for you, oil producer, nature has provided a natural storage tank. All you have to do to make your bet is not produce any more oil than you need to sell to cover costs.

All of which is to say, the world doesn’t need to experience declines in potential oil production to see a rise in oil prices. All it needs is for oil producers to see that such limits loom and begin betting on the near-certainty of rising prices. Of course, different countries will face different liquidity constraints; some leaders may find themselves producing full out in order to sustain their socialist paradise, particularly when prices temporarily dip thanks to recession. But at those times, other countries with fiscal room to spare should cut back their production further—to buy more, essentially, when prices are low in order to sell more when prices are high.

Even Jeroen van der Veer, the chief executive of Royal Dutch Shell, has admitted that oil supply may no longer keep up with demand by 2015. But the just-released cables, which detail a back-and-forth between the U.S. consul general and geologist Sadad al-Husseini, the former head of exploration at Saudi Aramco, confirms that the situation is serious.